As we have discussed, indemnities are one of the most important terms to be negotiated between parties in an M&A Transaction. The relative negotiating strength and sophistication of the parties (including their transaction teams) in an M&A Transaction, and the allocation of risk between the parties, will ultimately determine the final terms to be included in an M&A agreement.
MORE SOPHISTICATED PURCHASERS
One trend we note in Canadian M&A deals is that purchasers tend to be more sophisticated parties than sellers, and this results in the inclusion of more purchaser-friendly provisions relative to the indemnity, such as (note that the following is not an exhaustive list):
- the utilization of double scrapes;
- the inclusion of less onerous “materiality” and “material adverse effect” qualifiers;
- more negotiated exceptions to an upper cap (such as for breaches of the indemnitor’s fundamental representations, warranties and sometimes covenants; tax liabilities of the seller; “special” indemnification claims; and fraud or wilful misconduct committed by the seller);
- the inclusion of a tipping basket as opposed to a deductible or non-tipping basket;
- a lower minor cap;
- fewer limits or carve-outs to the scope of the indemnity;
- longer survival periods for the indemnity provisions, and/or more survival period carve-outs that offer unlimited or a longer duration for some parts of the indemnity; and
- more specific, expansive (and often onerous) representations and warranties made by the seller respecting the business being sold.
LONGER SURVIVAL PERIODS
Consistent with the trends we are seeing towards more sophisticated purchasers, and more purchaser-friendly provisions in an M&A agreement and indemnity provision, we are seeing the inclusion of longer survival periods, such as 18 or 24 months.
HIGHER INDEMNITY CAPS
Although Canadian M&A trends generally follow trends in the United States, one notable difference between private M&A deals in the two countries is that M&A Transactions in Canada tend to have higher indemnity caps, with most deals having a cap at between 25% to 50% of the purchase price, or even equal to the purchase price.
FEWER ANTI-SANDBAGGING PROVISIONS
“Sandbagging” relates to the right of a purchaser to bring an indemnification claim against a seller for breach of a representation, warranty or sometimes covenant by the seller that the purchaser had knowledge of prior to closing of the transaction or signing of the M&A agreement, but closes the M&A Transaction nonetheless. This is referred to as “sandbagging” because the purchaser may proceed to sign the M&A agreement/close the transaction with knowledge of a breach, and then “sandbag” the seller post-closing for legal recourse.
The inclusion of an “anti-sandbagging” provision is therefore in a seller’s best interest, as it will limit the purchaser’s legal remedies and recourse in relation to issues that the purchaser knew about prior to closing. However, the majority of M&A agreements either do not include an anti-sandbagging provision and are silent on the issue, or include a pro-sandbagging provisionthat expressly permits this from the purchaser.
REPRESENTATION AND WARRANTY INSURANCE
Representation and warranty insurance (referred to as “RWI” or “transaction insurance”) is supplemental insurance that a party (most often the purchaser) can obtain in an M&A Transaction to cover indemnification claims resulting from a breach of the other party’s representations and warranties. RWI can be used for both fundamental and non-fundamental representations and warranties. Almost all RWI policies in Canada for M&A Transactions are bought by purchasers.
Although the inclusion of RWI in an M&A Transaction and in the resulting M&A agreement will necessarily depend on negotiations and the risk allocation between the parties, Canadian deals have not embraced the use of RWI to the same extent as deals in the US. However, we see the trend of including RWI in deals generally increasing, as Canadian parties come to a greater appreciation for and understanding of the benefits of including a RWI policy in their deals.
FINAL THOUGHTS ON INDEMNITIES
While indemnities, representations, warranties and covenants are some of the most important negotiated terms for an M&A Transaction, the law affords parties the ability to specifically tailor these provisions to reflect the unique circumstances of each transaction and of the parties themselves. Having an experienced M&A transaction team and knowledgeable legal counselis one of the most important decisions that both purchasers and sellers can make in an M&A deal.
Carscallen LLP’s M&A Experience
Carscallen’s team of experienced M&A lawyers can assist both buyers and sellers in an M&A Transaction. We have extensive experience in advising on a wide range of purchase and sale transactions for both private and public companies and can help you understand your options, identify potential issues and how to overcome them, and to negotiate the most beneficial terms for your position.*This update is intended for general information only on the subject matter and is not to be taken as legal advice.